Monday, September 29, 2014

Linking Condo Activity with the Stock Market

Much of the business section in
recent weeks and months has been devoted to columns questioning the
sustainability of stock market index levels. The S&P/TSX Composite Index
closed the second quarter at its highest level ever, up 25% year-over-year,
with the value at the end of the fourth week of September 10% higher than at
the beginning of the year.

Some explanations offered for the
recent run-up include stronger oil prices, surging bank stocks and industrials,
discounts in relation to U.S. stocks, improving economic growth and central
bank commitments to hold interest rates low for an extended period of time.

While most financial industry
analysts see this recent rally as being in its final days and recommend
portfolio adjustments to gear up for disappointing market returns in the
future, the prospect for a significant correction remains uncertain. Robert
Shiller, the Nobel Prize-winning Yale economist, has compared today’s market
valuations to peaks in 1929, 1999 and 2007. However, many believe that the
market is in store for a series of minor corrections, to be followed up by more
buying as perceived ‘value’ grows against a backdrop of improving economic
fundamentals.

So why are stock market movements
important for the condo market?

While new condo sales have
followed the general path of many economic variables over the past 10 years
with various degrees of correlation, their fairly close relationship to the
stock market is worth paying at least some attention to.

Over the past five years in
particular, new condo sales have shown a strengthening, albeit still moderate, correlation
to stock market values with a one quarter lag. While this may seem
counterintuitive as condo investing is often thought of as a substitute for financial
investments, it can suggest that condo buyers use financial gains to invest in
condos, or buy units because they feel wealthier thanks to their rising
financial portfolio. The same relationship occurs on the downside, where buyers
feel more cautious as financial values slide. Whatever the reasons, more
research on this topic would be welcomed. (As a side note, condo sales have
shown a lower correlation to REIT index values).

The chart below shows that when new condo sales
volumes in the Toronto CMA and stock market growth pull away from each other, they tend to tend
converge in subsequent quarters. Sales often overcompensate when catching up, which
is shown to be followed by a more drastic change in course for the market (as
seen in 2012-2013). Recently, new condo sales have been rebounding alongside
the run-up in stock market values. However, sales remain well below their recent
peak in 2011 while the stock market is reaching new highs.

The questions then become: will
condo sales continue to benefit from the ‘catching up’ phenomenon previously observed
and, if there is a stock market correction of any magnitude, what impact will there
be on the new condo market? The problem with answering these questions is that
our historical point of view is limited as the new condo market is still
growing off a relatively small base from 10 years ago. While Urbanation has been tracking the market
for over 30 years, there lacks a sufficient volume of activity within the time
series to conduct a more proper statistical analysis.

Nonetheless, we can tell from
recent trends that the stock market now appears to be one of many indicators to
look at when assessing condo sales trends. Whether the stock market ‘treads
water’ or experiences an outright rout, repercussions for the new condo market
can be expected. This suggests that paying attention to financial industry
analysts may be (almost) as important as paying attention to condo industry
analysts.